358 PART 3 Long-Term Investment Decisions
In Practice
Information technology (IT) is one
of a company’s largest capital ex-
pense categories. In the rapidly
changing IT environment, man-
agers clamor for the latest hard-
ware and software upgrades to
keep IT systems current and im-
prove operational efficiencies. The
right IT applications, they claim,
can save millions in operating
costs. Financial managers, on the
other hand, struggle to control
capital spending while at the same
time approving projects that boost
the company’s competitive posi-
tion. Although some of these proj-
ects involve the latest hardware
and software, many more now fo-
cus on leveraging the firm’s invest-
ment in existing technology by
centralizing technology services,
integrating the different parts of a
company’s information systems,
and making similar improvements.
E-business projects are also on
the rise and now account for an
average of 15.5 percent of the total
IT budget.With so much at stake in
terms of dollars spent and poten-
tial benefits, managers must cre-
ate a business case that justifies
the project and shows how it adds
value—no easy task. In addition to
measuring dollar benefits that ap-
pear on the firm’s income state-
ment, they must attempt to quantify
indirect and qualitative benefits.
This may be straightforward for
transactional systems, where or-
der volume is a critical measure.
But how does the company assign
a dollar value to, for example, the
increased customer satisfaction
generated by a new, easier-to-use
interface for its customer informa-
tion system?
During 2001, declining sales
and an uncertain economic future
meant companies had to choose IT
projects that yielded the greatest
return on investment or gave the
biggest strategic advantage. Gary
Clark, director of corporate IT ser-
vices at La-Z-Boy Inc., the leading
U.S. manufacturer of upholsteredfurniture, said, “Previously, we
would look primarily at high-level
issues. Now, we’re not only exam-
ining the details of a project but
also the underlying assumptions
and the business case. It’s all
about cost and results.” La-Z-Boy
decided to postpone projects re-
lated to information security and
general business systems but
moved ahead with strategic tech-
nology projects. For example,
analysis of a new payroll and hu-
man resources system showed
that it should lower costs for the
entire organization.Sources: Shari Caudron, “The Tao of
E-Business,” Business Finance
(September 2001), downloaded from
http://www.businessfinance.com;Sam Greengard,
“IT: Luxury or Necessity?” Industry Week
(December 1, 2001), downloaded from
http://www. industryweek.com;and Ivy
McLemore, “High Stakes Game,” Business
Finance(May 1999), downloaded from
http://www.businessfinance.com.FOCUS ONe-FINANCE Information Technology’s Big Byte
independent projects
Projects whose cash flows are
unrelated or independent of one
another; the acceptance of one
does not eliminatethe others
from further consideration.
mutually exclusive projects
Projects that compete with one
another, so that the acceptance
of one eliminatesfrom further
consideration all other projects
that serve a similar function.
unlimited funds
The financial situation in which
a firm is able to accept all
independent projects that
provide an acceptable return.
Independent versus Mutually Exclusive Projects
The two most common types of projects are (1) independent projects and (2)
mutually exclusive projects. Independent projectsare those whose cash flows are
unrelated or independent of one another; the acceptance of one does not elimi-
natethe others from further consideration. Mutually exclusive projectsare those
that have the same function and therefore compete with one another. The accep-
tance of oneeliminatesfrom further consideration all other projects that serve a
similar function. For example, a firm in need of increased production capacity
could obtain it by (1) expanding its plant, (2) acquiring another company, or (3)
contracting with another company for production. Clearly, accepting any one
option eliminates the need for either of the others.Unlimited Funds versus Capital Rationing
The availability of funds for capital expenditures affects the firm’s decisions. If a
firm has unlimited fundsfor investment, making capital budgeting decisions is
quite simple: All independent projects that will provide an acceptable return can